More gold for your golden years

Three smart, simple steps to a more financially secure retirement

SAN FRANCISCO (MarketWatch) -- Bitten by the bear one too many times and uncertain about their jobs and the economy, investors have avoided stocks even after the market's rapid ascent. Indeed, the market's strong rebound over the past 10 months only makes many sidelined buyers more afraid to get on board, and the sell-off last week likely exacerbated those fears. Their mantra: We won't get fooled again.

Uncertainty, mistrust, cynicism -- this is what we feel when we feel taken. And investors are right to be suspicious. "This time it's different" was Wall Street's mantra for a bull market that had lost its compass and later, a housing market flush with cheap credit. Nothing was different, of course. The booms ended badly, and many investors are still paying a high price.

This time, you can be different. The 1990s market is gone, along with its wild double-digit yearly gains; plan instead how to make your money last into your 90s. Act decisively, learn about financial matters, and put knowledge into practice. Stocks will take another hard tumble -- or maybe bonds will be next. If you're certain of where you stand, you'll have little to fear.

"Hoping [your investments] are going to come back isn't going to change anything," said Nathan Dungan, founder of financial consulting firm Share Save Spend. "Hope without a plan is denial. If you don't have a plan for dealing with the current environment, nothing is going to change."

1. Dollar-cost average into your asset allocation

Which is more influential to investment returns: individual stock and bond selection or how much money you invest in a broad category? Studies show that asset allocation -- the percentage of your portfolio committed to stocks, bonds, cash and other holdings -- is far more influential than what you actually own.

You can control asset allocation, unlike the performance of a stock. Allocation in turn is a function of your risk tolerance. Some folks don't like scary movies, so they don't watch them. If the 2008 market was too horrible, then don't invest as much in stocks.

"You have to remember the past -- what it felt like to experience that volatility -- and decide whether you can go through that again," said Ross Levin, a financial adviser in Edina, Minn. "If you can't handle that volatility, you're either going to have to spend less money or work longer."

A standard rule of thumb is to use 100 minus your age as a yardstick for how much to have in stocks. So if you're 40 years old, put 60% of the portfolio into stocks. If you can't stomach much volatility, invest like a retiree and keep a larger portion in bonds.

For an even smoother ride, dollar-cost average into your allocation. That means investing a set dollar amount on a regular basis, purchasing more shares when prices are low and fewer shares when prices are high. This automatic approach takes emotions out of buying and can vastly improve your total return, especially in choppy markets.

Consider the fortunes of an investor who methodically put $500 into the S&P 500 SPDR
SPY, +0.03%
at the close of the first trading day each month beginning on Sept. 2, 2008 and ending on Aug. 3, 2009. At the end of those 12 periods, the $6,000 invested would be worth $6,578, for a return of 9.6%. The ETF, meanwhile, tumbled 21.5%.

2. Catch up as much as you can

Yes, it's better to sock away retirement money early. If you're a late starter, don't wait any longer. Those over age 50 can sink up to $6,000 into a traditional IRA each year, or as much as $22,000 in a traditional 401(k) plan. The same goes for your spouse.

Dollar-cost averaging is effective for investors trying to catch-up. Start by committing a portion of each paycheck according to your portfolio allocation. For example, $100 every two weeks to a 60%/40% split between stocks and bonds would give $60 to stocks and $40 to bonds.

In this way, you're likely to stick to a disciplined strategy to keep from jumping headlong into inflated markets, and you'll be a true contrarian, against-the-herd buyer in the darkest hours.

"Everyone wanted to be a stock investor in [the bull markets of] 1998 and 1999, and nobody wanted to be a stock investor in 2008," said Fran Kinniry, a principal in the investment strategy group at mutual-fund giant Vanguard Group. "Most other purchases you want to buy at a discount. For some reason, investors like to buy [stocks and bonds] when they've risen in price."

3. Consider a Roth IRA conversion

The tax benefits of the Roth IRA are available to all taxpayers now that income restrictions on conversions have been lifted, but switching to a Roth from a traditional IRA isn't right for everyone.

Who should convert? If you expect your income tax rate to be higher in the future and don't need the money immediately, the Roth IRA would be advantageous.

The Roth's chief attraction is that withdrawals are tax-free for people over age 591/2 who have owned the account for at least five years. Moreover, the Roth requires no minimum distributions, or withdrawals, so you can bequeath the entire account to your heirs, who can then take the original amount of your conversion tax-free.

Minimum distributions from traditional IRAs, in contrast, are mandatory after age 701/2 and taxed as ordinary income, as if you'd earned that money on the job. And there's no advantage for your heirs.

A Roth conversion may not be a good choice if you anticipate being taxed at a lower rate, or if you need the money within five years.

Ideally, you can pay the tax without tapping retirement funds. And keep in mind that if you're under age 591/2, any IRA money you take to pay the tax could be hit with an additional 10% penalty.

If you have no idea what your tax bracket will be when you retire, you might make a partial conversion, leaving some money in the traditional IRA, to give you what's called "tax diversification."

Additionally, there's a temporary tax break right now: People who act in 2010 can pay half the conversion tax in 2011 and half in 2012 -- meaning you can defer a portion of the obligation until April 2013. But remember that income tax rates are slated to rise in 2011 after the Bush administration tax cuts expire. That would return the top marginal rate, for example, to 39.6% from 35%. See story on higher tax rates ahead.

Now, suppose this 2010 conversion turns out to be a mistake. You have a chance to reverse it until April of next year -- and the following October if you file for an extension -- through what's called a "recharacterization," which is essentially a penalty-free do-over.

One reason to undo the conversion would be if the markets turned south and you'd be liable for taxes on the account's original, higher value. Later, if investment conditions improve, you can convert the funds back into a Roth (there are restrictions on how soon you can re-convert so consul a tax professional).

Any decision to convert or not should be made with professional help. Still, the Roth's flexibility has many financial experts, well, converted.

"I did it," said Ed Slott, a tax specialist and founder of IRAhelp.com. "Now this money is going to grow for me tax-free forever. I think we're in the lowest tax rates we'll ever see for the rest of our lives. This is the deal of the century."

Mortgage Rates

Powered by

This advertisement is provided by Bankrate, which compiles rate data from more than 4,800 financial institutions. Bankrate is paid by financial institutions whenever users click on display advertisements or on rate table listings enhanced with features like logos, navigation links, and toll free numbers. Dow Jones receives a share of these revenues when users click on a paid placement.

Intraday Data provided by SIX Financial Information and subject to terms of use. Historical and current end-of-day data provided by SIX Financial Information. All quotes are in local exchange time. Real-time last sale data for U.S. stock quotes reflect trades reported through Nasdaq only. Intraday data delayed at least 15 minutes or per exchange requirements.